Properly Analyze Your Rate of Return
It’s pretty easy to understand your rate of return on your investment statement: most companies clearly display the result. Some even use red numbers for a negative rate of return and green numbers for a positive return. It’s usually quite clear to see your current rate of return and your average over the life of the investment. The difference I sometimes see is whether a statement shows the return gross before fees, or net after fees. I always remind people that the net-after-fees return is what is important, because that is what’s real to the investor. It’s too bad that other investments are not as easy to evaluate, because people often do not properly analyze their rate of return.
Many people know my story. Before I was a Wealth Management Advisor working with other people’s money, my husband and I built our own net worth, starting our investment portfolio with real estate. We learned the different metrics of calculating real estate rates of return. The most common mistake I find when talking to real estate investors is that they forget to take into account the expenses associated with ownership. For example, if one paid $1,000,000 for rental property and sold it for $2,000,000 they may say they doubled their money. But, to properly assess what they’d actually made, they’d have to subtract from the profit, all of the costs of ownership over the years such as taxes, maintenance costs, insurance, closing costs for buying and selling, interest paid on a mortgage, association fees and costs of permits, to name a few. Then, they’d have to add in revenue collected from rents and account for depreciation. If they were personally managing the property, it is appropriate to factor in cost of labor, even though it’s their own. Remember to subtract out mortgage payoff and capital gains taxes due. Now with the adjusted number, factor in the number of years of ownership. Because of the complexity, it’s hard for most to accurately compare the performance of different types of investments such as personally owned real estate to investment of stocks, bonds or mutual funds.
I’ve seen the same simplistic thinking with other investments. One gentleman I spoke with was blown away at the value of stock he’d inherited from his grandfather, versus what his grandfather bought the stock for. We eventually looked at the original purchase date of 1987 and realized that the performance was about average compared to the rest of the stock market.
Some investments easy to understand in their performance, while others are more complex in properly analyzing their rates of return.